Table of Contents
Introduction: Navigating the Opportunities and Challenges in Digital Health
Unit Economics for Care Delivery
a. Tracking and Incentivizing Clinician Productivity
b. Utilizing 1099 and W-2 Clinicians
c. Extending Capacity with non-clinicians and Technology
Balancing Growth and Profitability
Achieving Key Outcomes
Conclusion: A Path to Sustainable Success
In Part 1, we reviewed how tech enabled services businesses should define their unit economic and margin cost structure, and the impact clinician staffing and technology utilization can have on margin structure. In Part 2, weâll examine the trade-offs between growth and profitability and how tech-enabled services businesses can track performance and evaluate common dilemmas on the path to building a large sustainable enterprise.
Balancing Growth and Profitability
An inherent tension exists between growth and profitability for all venture-backed startups. Venture-backed models must grow to become large companies and deliver venture-level returns to investors – about a 5-10x return on capital invested. These rapidly scaling companies have to spend to grow, which can reach a fever pitch in capital-intensive healthcare services where the cost of clinicians is usually the driving expenditure. If the unit economics lessons mentioned above are not heeded, companies can incur losses at the same growth rate, resulting in an ongoing need to raise capital. This complicates the investment thesis for tech-enabled services as companies that have raised significant amounts of capital – often hundreds of millions of dollars – dilute the ownership level of the operating team and early investors, which further muddles an attractive return profile.
Robbins suggests that GV is investing in tech-enabled services more than ever. “Investing in tech-enabled healthcare services can be challenging, but for fixable reasons. In the past, many companies grew on shallow revenue models tied to short-term gains and incremental arbitrage in federal programs like risk coding, which are now facing pushback. Making matters worse, these companies raised significant capital on the promise of future unit economics but struggled to reach scale without burning through cash. In the process, many lost focus on strengthening their clinical models. At GV, we’ve instead focused on companies that are laser-focused on delivering measurable clinical impact, which naturally leads to profitability when done right.”
Explains Tom Lee, “We tend to avoid the whims of the market when building a long-term approach or strategy. In addition, we shy away from binary-state mindsets – for example, ‘growth and technology at all costs’, or ‘margins and profitability at all costs.’ There are always trade-offs, and you can’t be 100% predictive about how your business will perform. But if you have a solid underlying economics around your business, the long-run averages should work in your favor.”
Companies must balance the desire for growth and building a big company while also ensuring strong unit economics and a path to ultimate profitability. Successful companies have used a handful of tactics to ensure they are scaling efficiently without compromising their financial health or operational goals.
Tracking Burn Multiple and Free cash flow margin
Managing the balance between growth and cash burn among venture-stage companies is often imprecise and subjective. This balance is frequently tied to a company’s “traction”: typically measured by its progress against key revenue and growth targets, as well as its ability to continue raising capital. In reality, growth frequently takes longer than expected as companies refine product-market fit and build high-performing teams. During this period, companies from Series A to C can continue raising capital, even if cash efficiency is not fully optimized, to blitzscale and become a category-defining company.
Well-funded companies often focus on cash management only when cash is running low. With large amounts of capital on hand, companies and investors tend to view additional runway as more time to hit ambitious revenue goals. However, this creates a situation where both teams and investors may only confront the hard facts of capital efficiency when it’s too late to correct a faltering course. Implementing real-time metrics that allow for separating market excitement from actual performance is invaluable for ensuring long-term viability.
One effective measure of cash efficiency, borrowed from SaaS businesses, is the Burn Multiple. This metric is calculated as Burn Multiple = Net Burn / Net New ARR. A lower number indicates better cash efficiency; a Burn Multiple below 1 is ideal. When the Burn Multiple exceeds 3, it signals that a company is burning three times as much capital than it is adding as revenue to the platform, placing it in a riskier position. While early-stage businesses may not score well on these metrics as they are still refining their product-market fit and establishing their customer base, tracking the Burn Multiple over time can provide valuable insights into performance and help guide financial decision-making.
Any scaling business aims to reach profitability and generate free cash flows. Most venture-stage companies will never reach profitability, but the likelihood of success and potential exit lies in the positive progression towards profitability as acquirers contemplate potential synergy value that could quickly make an acquisition accretive. Companies should reduce losses and improve free cash flow margins over time, in line with their plans for revenue growth. Tracking free cash flow margin and burn rate multiple allows you to gauge progress and pace, respectively, on the way to a profitable business.
Jared Kesselheim, a Managing Partner at Transformation Capital, explains, “Tech-enabled services have recently received a bad rap for being capitally intensive. While we are seeing AI-native technology companies scale at faster rates than we have seen before and with much better capital efficiency, we continue to pursue and invest in novel services models as well. We believe that many opportunities exist to deliver higher quality and more cost-efficient care with novel services models– and that tech-enabled services companies can also achieve profitability faster than earlier generations of companies by leveraging more widely available third-party AI tools. The multiples paid for these companies still need to reflect that these companies have a services component.”
In 2023, Bessemer Venture Partners (BVP) published a very helpful rubric in their regular health tech market analysis allowing companies to benchmark their performance against a basket of successful comps. For successful tech-enabled services companies in the $1-10 million ARR (Annualized Revenue Run Rate), the average free cash flow margin is -255%. However, those same businesses are growing ARR at 250%, meaning that companies are burning more than twice their revenue in cash but are growing revenue more than 3x YoY. As companies scale to $10-25 million ARR, the free cash flow margin improves to -110% as revenue growth slows to 135%. In their analysis, BVP suggests that even at $100 million in ARR, many of these scaled businesses still do not reach profitability with average -10% free cash flow margins.
Sofia Guerra, co-author of the BVP Benchmarks article, comments, “As multi-stage healthcare investors, we were commonly fielding questions from current and prospective portfolio companies about fundraising milestones, optimal growth rates, unit economics, and industry trends. We recognized that this data is locked away, proprietary to private companies, and behind closed walls of VCs. With our benchmark database, we aimed to democratize this information and engage in discussions with the industry on building resilient and successful businesses in the healthcare sector. We also understood that any of these success metrics could not be examined in isolation and would change over time.”
Accounting for Cash and the importance of RCM
For many early-stage companies, building a product, acquiring customers, and delivering products/services are top priorities as they launch commercially. To better reflect the rapid growth of their business, these teams often choose to use accrual accounting, which recognizes revenue when a product/service is delivered and recognizes expenses when they are incurred. This is opposed to cash accounting, which dictates you can only recognize revenue once you receive cash for services/products and realize expenses when you actually pay them. This creates an environment where, on an income statement basis, a company may appear to be achieving strong EBITDA and cash flow margins with minimal burn and working capital needs. But from a cash flow perspective, on a month-to-month basis, the company may be burning 2-3x the expected cash, and in some cases, these companies are never able to collect the cash and will have to revise past income statements due to bad debt.
This phenomenon of a significant discrepancy between the income statement and cash flow is often seen in payer-reimbursed services, where revenue cycle management (RCM) can delay receipt of funds in exchange for services rendered. RCM in payer-provider transactions is a purposefully opaque and arcane system. Payers will deliberately delay or not make payment if a variety of rules and regulations are not followed. Further, the long tail of staff and technology systems, which must appropriately document and submit a claim, adds further risk of failure in a complex process. To further complicate matters, many insurance products require some component of patient co-pay and thus digital health companies must develop systems to collect directly from patients as well.
We have seen early-stage companies deliver products and services that account for 100% of recognized revenue, but then only collect 50-60% of the cash. The remainder of this recognized, but uncollected revenue is collected in growing accounts receivable that may never convert to cash. This exacerbates an already cash-flow-negative operation for a growing startup.
To prevent this drawback of accrual accounting, we recommend that teams take a stepwise approach. First, recognize that a robust RCM function is a must-have out of the gate, and not something that you can implement once at scale. RCM processes will impact other components of your service delivery organization, so it’s best to avoid developing bad habits and processes early on. Second, look for expertise and prior experience in building out your RCM function. This may be achieved by hiring expert leaders or working with a third-party firm (often referred to as Business Process Outsourcing, or BPO) to ensure you maintain a high rate of current collections. Best practices aim for 95% of collections to be realized, with less than 5% of revenue being written off as bad debt. Often, starry-eyed clinical entrepreneurs believe the promises that their EHR module can handle all the complex RCM options and are sorely disappointed. Thirdly, this is a hotbed of innovation in AI / LLM-led product creation. Given that RCM can be a costly capability due to its repetitive and labor-intensive processes, it is one of the first use cases for healthcare automation companies. While we anticipate significant innovation in this area, companies should experiment wisely as they relegate their vital RCM functions to early-stage companies.
Josh Willeford, CFO of Positive Development, explains, “Throughout my career as a CFO of healthcare services companies, I’ve seen the myopic focus scaling companies have on contracting with payers and receiving preferential reimbursement rates and value-based contracts while overlooking their cash collections operations and revenue cycle management processes. Our model of care is designed to drive strong clinical results for families and drive value for payers, so we too, have preferential, value-based contracts in the market. We have over 500 clinicians in the field, from diverse clinical backgrounds and experience levels, delivering services to children for more than 20 different payers across the country. The sheer complexity of driving standardization and best practice across that care ecosystem has taken years to get right. Our keys to success have been threefold: 1/ technology to simplify appropriate and compliant billing practice for our clinicians, 2/ Process improvement workflows to ensure our clinicians are practicing at the top end of their license and receive feedback when they veer from best practice, and 3/ Strong RCM leaders who have experience in streamlining all of these activities and can provide early warning systems when reimbursement begins to veer from expectations.”
Pacing Operating Expenses with Growth
A common challenge for early-stage companies is right-sizing their corporate overhead expenses. The principles of Operational Leverage and scale suggests that the ratio of fixed costs of operational departments of Research & Development, Sales and Marketing, and General and Administrative Expenses, to Revenue, should decrease over time. Many investors encourage early-stage companies to build “rock star” executive teams, demonstrating a “chicken or egg” phenomenon that begets future growth. This is often good advice, presuming these expensive executive teams can jump-start and/or sustain growth. But at what rate should early-stage companies experience operational leverage, and at what point do you presume it’s not working?
The Burn Multiple calculation described above is a bottom-line measure and does not differentiate inefficiency above or below the gross margin line. Teams and investors should spend time benchmarking their operating expenses (OpEx) by line item and then evaluating the evolution of these gross operating expenses to revenue ratios over time. It is natural for teams to troubleshoot missed revenue goals by spending more to close perceived operational team gaps, further sending these ratios in the wrong direction.
Bogle states, “Perhaps one of the most common missteps we see when performing diligence on early-stage companies is excess corporate infrastructure too far ahead of growth. A company can easily accelerate unnecessary cash burn when they have several $500,000 per year executive compensation line items without the requisite traction. Companies need to have a solid understanding of how close they are to generating positive cash flow and then timing their hiring or firing related to that pace. If a strategic balance on this front isn’t met, operations and growth can experience undue pressure that could preclude a start-up from successfully getting off the ground floor.”
Again, the Bessemer benchmarks are helpful when considering Operating Expense / Revenue ratios in the context of growth rate. On average, tech-enabled services businesses with $1-$10 million of ARR have an OpEx-to-revenue ratio of 250%. At the same time, these same businesses have an average ARR annual growth rate of 250%. As these businesses scale to $10-$25 million in ARR, the OpEx-to-Revenue ratio decreases to 160%, while the ARR growth rate drops to 135%. This suggests that your business should grow top-line revenue but also reduce its OpEx-to-revenue ratio by roughly 36% as it scales. Implied in this relationship is that a company with a $10-$25 million ARR range and an OpEx/Revenue ratio of 160% (clearly unprofitable) is viewed as above average if it is growing at least 135% annually.
Guerra explains, “Upon review of our benchmark data, it was clear that founders and CEOs commonly face trade-offs. We noted that companies with high growth rates and gross margins, but low contribution margins and high burn rates, were highly valued early on. However, as they scaled, they ultimately needed to demonstrate additional profitability and proof points of sustainability. It’s important to understand what best-in-class looks like for your specific business and strive to be in the top quartile of performers. Most importantly, operators need to understand and be able to explain to investors the drivers of historical performance and future growth.”
Trading Revenue for Margin
Most early-stage companies focus on validating a market for their products or services, defining success simply as acquiring more paying customers. However, as a company matures, operators must critically evaluate whether new customers and new revenue are accretive (margin-generating) to their existing business model. Failing to make this assessment can lead to unprofitable growth and unsustainable business practices.
With this filter, not all new customers are good customers. Naturally, large annual contract value (ACV) enterprise accounts are enticing and appear to be game-changing for early-stage companies. However, from a cost accounting perspective, these customers can be deceiving. The additional customization or features required to service these accounts can erode gross margins. Many entrepreneurs mistakenly believe they will “grow into” these larger contracts by signing additional customers who will also utilize and pay for these new features. Examples include new modules to existing platforms that require significant build and maintenance or new national / regional service capabilities that demand additional staffing. Sales and operational teams might celebrate big quarterly or annual wins, but CFOs must dig deeper to understand why gross margins remain low and the burn rate does not improve. In these cases, scale does not necessarily enhance unit economics, as you can’t always grow into profitability.
To avoid trading revenue for margin, teams must first understand the cost structure required to serve a new customer before locking in a reimbursement rate. If a gap in service or technology exists that is needed to serve the customer, this should be communicated during the contracting process. By doing so, teams can price contracts appropriately to maintain the existing gross margin, if not improve it. If customers resist negotiating on price up front, teams should incorporate ROI benchmarks and guarantees for price increases to ensure profitability over time. This approach can shift the contract renewal conversation, which often involves large enterprise customers expecting price cuts, driving struggling margins in the wrong direction.
If a persistent gap exists in a service offering that has no potential to be accretive, early-stage companies can consider partnering and subcontracting with a 3rd party company to fill this gap. When going down the partnering route, it’s essential to weigh the benefits against the costs and risks of integration and disintermediation. Teams need to ensure they can grow profitably into new products or customer segments. If profitability is not achieved, itâs crucial to evaluate whether these customers are truly beneficial for the business. Ignoring this evaluation may result in long-term financial underperformance.
Brooke Boyarsky Pratt, CEO of Knownwell, a leading tech-enabled healthcare home for patients with Obesity and a Flare Capital portfolio company, relates, “Given that we have a notable brand in the very active obesity management space, we are frequently approached by health systems, pharmaceutical companies, and other stakeholders who would like to partner with us to achieve their goals of improving care models for overweight populations. While we are eager to explore opportunities with these groups, we remain focused on our core delivery and business model and take care not to jeopardize either for additional market presence. We’re cautious to ensure that our business – and most importantly clinical – model is aligned with our Partners to ensure profitable growth.”
Leveraging Customer Cohort Analysis for Sustainable Expansion
Before accelerating growth and expanding into multiple markets or customer segments, a company should understand its path to profitability in its existing lines of business.
A vital strategy in achieving this is through detailed performance analysis and understanding unit economics by customer cohort. Patient groups vary widely in terms of medical complexity, demographics, geographic distribution, referral sources, and payment models. These variations influence the profitability associated with serving each group, with some cohorts more likely than others to yield sustainable unit economics for a particular clinical model or client group.
By segmenting customers into cohorts and then evaluating subgroups on performance metrics such as retention, lifetime value, acquisition cost, cost to serve, and clinical outcomes, organizations can pinpoint specific cost drivers and uncover revenue opportunities within each segment. This detailed approach allows tech-enabled service organizations to “de-average” their business and understand persistently low gross and contribution margins. This next level of analysis can inform strategy around pricing, service and operational margin en route to building a sustainable and profitable model.
Chris Hocevar, CEO at Help at Home, one of the nationâs largest community-based home healthcare companies and Executive Partner at Flare Capital, explains that “De-averaging performance allows entrepreneurs to better understand the best and worst parts of their business so that you know what to do more or less of. Many companies pride themselves in a metric-driven culture but only chase basic efficiency ratios such as average LTV/CAC or ARPU but don’t realize these averages can mask trends on each end of the spectrum.”
Navigating Patient Acquisition and Enhancing Lifetime Value
Tracking the performance of patient value and acquisition across different customer segments is crucial, as it highlights the most valuable groups and those yielding the best outcomes â key targets for growth initiatives.
Maintaining a strong LTV/CAC (Lifetime Value to Customer Acquisition Cost) ratio is necessary for ensuring that a company acquires patients sustainably and is generating adequate value for its business. Lifetime Value (LTV) is calculated for in tech-enabled services by estimating the gross margin a patient generates throughout their relationship with your company after accounting for churn. Conversely, Customer Acquisition Cost (CAC) encompasses all marketing and sales expenses over a specific period, divided by the number of new patients acquired during that time frame. Together, these metrics form the LTV/CAC ratio, providing a clear measure of return on investment for marketing and patient acquisition efforts. Achieving an LTV/CAC ratio of 3x or higher is generally viewed as good, with top-performing companies aiming for at least 6x.
To unpack and better understand the drivers of CAC, companies need to better understand their acquisition funnel and the conversion rates at each step in the patient onboard process. For online acquisition channels, this metric tracks how many website or app visitors convert into patients, highlighting the patient journey from initial contact to successful engagement. Managing offline channels is also crucial, as drop-off rates can occur when receiving referrals from payers and providers. Addressing potential bottlenecks such as the appropriateness of the product’s clinical offerings, the timely availability of clinician capacity to serve, and the eligibility of reimbursement with a patient’s insurance plan, is key to optimizing both the online and offline acquisition processes.
Many companies with large business development teams utilizing B2B channels to acquire patients through enterprise-wide contracts with payers or health systems sometimes perceive minimal acquisition costs. This could not be farther from the truth; not only are the costs to land enterprise contracts an acquisition cost, but the cost to drive referrals and engage and onboard the patient into care should also be an acquisition cost. Companies must factor in these costs to truly understand the cost efficiency of their acquisition vehicle to determine if they should continue to pour gas on the fire of a particular part of their business.
After successfully navigating the acquisition funnel, the focus shifts to retaining patients and enhancing their satisfaction, which are vital indicators of service quality. Measuring retention through three-month, six-month, and twelve-month rates, alongside analyzing patient feedback and Net Promoter Scores (NPS), offers insight into patient loyalty and areas for improvement. Successful retention further improves LTV of patient cohorts and can reduce acquisition costs to maintain capacity utilization levels.
Once a company has established segments with sustainable acquisition costs, there is an opportunity to enhance customer lifetime value through offering of complementary add-on / upsell bundled services. A prime example of this strategy can be seen with Sword Health, which initially launched as a digital physical therapy solution. Subsequently, they broadened their offerings to encompass additional tech-enabled services in areas such as pelvic health care and personal training. Similarly, Maven Clinic initially introduced Maven Maternity and Maven Fertility, and later expanded its portfolio to include Maven Parenting, and Maven Menopause, enhancing the value and services available to their customer base.
Conclusion
As tech enabled services businesses grow, it’s important for operators to pace their rate of growth with improvement in margin structure and overall cash losses. Operators should strive to run a lean business that exhibits operational leverage and has cash efficient operations. Entrepreneurs should critically examine their customer accounts to ensure accretive growth and should build a cost-effective patient acquisition vehicle that is aligned with the economic value created. These efforts will bring financial discipline to operations and growth and will maximize enterprise value for potential financial or strategic partners.
In Part 3, weâll examine which operational, clinical, and financial outcomes tech enabled services businesses should track and generate to achieve their goals. Read Part 3: Achieving Key Outcomes here.
Straight to the Source
To go a click deeper, we are convening these voices around the virtual table for our next expert roundtable webinar. Join us on June 10th at 12PM ET alongside this brilliant group of innovators, executives, and investors who will share their hard won lessons and tactical strategies. Register here.
